Real Estate Chronicle

A blog dedicated to real estate matters, finance as well as general economics and political economics issues. Posts written by Luigi Frascati, B.Econ. Your comments and suggestions are appreciated.

Saturday, April 29, 2006

Bubbleburg!

Only the Yankees seem to worry about real estate bubbles - but not the Confederates ...

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The bubble is coming! The bubble is coming! Yeah, right … and so are the aliens, at least those belonging to the Empire of the Rising Sun.

In the general order of things, when short-term interest rates of U.S. Treasury bonds exceed long-term rates, market sentiment suggests that the long-term outlook is poor, and that the yields offered by long-term fixed income will continue to fall. This generates an inverted-yield curve, typically an indicator of a pending economic recession. So far, however, there has been no inversion of any consequences in the yield terms of U.S. Treasury bonds as measured from the 91 days through the 30 years redemption periods. In addition, long-term rates are behaving very, very well partially because of the tremendous demand for long-term treasuries that has been coming from places like Japan.

Clearly, most real estate investors care about the future of interest rates, and so do most lenders. In the United States, the Treasury yield curve is the first mover of all domestic interest rates and an influential factor in setting global rates. As governments compete with corporations and lending institutions to attract investors in the open financial markets, any bond or debt security that contains greater risk than that of a similar Treasury bond must offer a higher yield. For example, the 30-year mortgage rate historically runs 1% to 2% above the yield on 30-year Treasury bonds. While this is true to a certain extent, it has not influenced the spread between short and long-term rates in the beginning months of 2006. As long-term rates on treasuries are stationary, the recent hikes of interest rates seem to have affected only the short-term bond rates.

The Treasury yield curve reflects the cost of U.S. Government’s debt and is, therefore, ultimately a supply-demand phenomenon, central to the Fed’s monetary policy. If the Fed wants to increase rates, it supplies more short-term securities in open market operations. The increase in the supply of short-term securities restricts the money in circulation since borrowers give money to the Fed. In turn, this decrease in the money supply increases the short-term interest rate because there is less money in circulation (credit) available for borrowers. Which is exactly what has happened in the first few months of 2006.

But two additional very important events have also occurred, concomitantly. First, Japanese investors have and are snapping up U.S. treasury long-term bonds at a pace almost double that of equivalent long-term Japanese treasury bonds. Secondly, Chinese investors are beginning to do the same thing. Much to the dismay of Beijing, who recently announced its intention to issue long-term treasury bonds worth some 100 billion Yuans to finance mainly infrastructure development, science, technology and education facilities, environmental improvement and ecological conservation projects and technological upgrading in enterprises, Chinese investors and savers prefer not to convert their dollars into Yuans. Even New Delhi is getting into the bond game. India – which all and by itself sits on a pile of some US $150 billion – is purchasing US Treasury long-term bonds and reselling them to Indians for a mark-up.

Bottom line, therefore, is that the only ones who seem to be worried about the American debt are, well ... the Americans. Everybody else seems to be willing to give the U.S. Treasury all the credit in the world, literally. Which is not only a political vote of confidence for Washington but also, in retrospective, makes a lot of sense if one thinks about it. Since, if you are a non-US national sitting on a pile of US Dollars, and are looking to invest into low-risk securities there is no better place to invest your money than into debt instruments guaranteed by, well … the United States Government. Which fact is sure to lighten up with joy a great many Confederate faces in the Bush Administration, who are beginning to see their financial and foreign policies vindicated, at last.

How does all this affect American real estate consumers?

For one thing, if investors of the Asian Tigers are willing to inject their ‘Godzilladollars’ back into the U.S. economy basing their decisions only on the financial strength and good reputation of the U.S. Treasury, and without a corresponding increase in U.S. bonds long-term interest rates, it means that long-term mortgage rates are not going to increase. Therefore, since adjustable-rate mortgages (ARMs) have interest-rate schedules that are periodically updated based on short-term interest rates, but not on long-term, homebuyers are better off to finance their properties with fixed-rate loans, which are bound to become more attractive than adjustable-rate loans.

Moreover, foreign investors such as the Japanese historically have viewed North American real estate assets inexpensive, if not outright cheap, compared with their domestic real properties. If you are used to pay U.S. $1,200 per square foot for an apartment in Tokyo, nothing that North American real estate markets can throw at you is going to scare you one bit. Chinese holders of foreign real property, on the other hand, have never left North America. They have merely scaled down their real property assets, but there has not been any great exodus towards China. Which fact, all an by itself, suggests how the Chinese themselves eye with uneasiness the prolonged economic boom of the People’s Republic. And rightfully so, one might add, in light of the growing discontent, chagrin and resentment caused with each and every passing day by the gap existing between the wealthy Chinese of the coastal regions vis-à-vis the immensely more numerous poor sections of the population in the hinterland.

Thirdly, with a self-sustainable debt financed by foreigners, the Fed’s job of managing the equilibrium between inflation and economic growth through the handling of interest rates becomes even easier, to the extent that it makes all the more unlikely the occurrence of the cascade of mortgage defaults with a flood of foreclosures, which in turn would bring prices down – the typical real estate bubble that a great many ‘bubbleologists’ have predicted, for now with no foundation whatsoever.

Now more than ever it seems that the impact of the present cooling-trend that we are witnessing in North American real estate markets can only be interpreted as the consolidation of markets wealth achieved thus far, and that this trend is expected to settle real estate markets to new, more commensurate pricing levels before appreciation will surge upwards once again. Particularly in light of the fact that there are still plenty of consumers out there – especially domestic buyers – who are ready, willing and able to purchase.

Wednesday, April 26, 2006

Real Estate 3 – Rise Of The Machine

As society evolves in a futuristic world, so does Real Estate (and Arnold Schwarzenegger ...)

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As a real estate Agent, I have witnessed personally over the years the industry constantly and continuously changing and rejuvenating itself. Changes have stemmed out of improved technologies, different consumers and an overhaul of our entire lifestyle, especially here on the West Coast. People expectations are different today, both in terms of the services sought and products demanded. Expectations are so different, in fact, they have impacted even the engineering and architectural aspects of real estate.

Not too long ago the Strategic Issues Subcommittee (SIS) of the American National Realtors Association was asked to identify the top trends influencing changes in the industry, as well as to give a futuristic outlook of what the real estate landscape will look like a few years to come, both in the United States and in Canada. Their findings are extremely interesting, both from a professional viewpoint as well as from the social sciences perspective. Ultimately real estate is a "people's business", and the following major factors speak volume about how we are all going to think and act. Here they are.

[ ] Changing consumers values and behaviors

The very concept of family is changing. Family has been instrumental to the creation of all human civilizations throughout the centuries, but this pivotal knot is going to be entirely different. No more Dad, Mom and two kids. An ever increasing number of people will be living alone or as a couple at the most. The general trend throughout Western societies is not to have children, and this trend will be more remarked in times to come.

'Home Sweet Home' will change too. Our children will be living mostly outside, and will not require large homes or, for that matter, large apartments. The one-bedroom and den will be the standard fare a few years down the road. On the other hand, consumers of tomorrow will be increasingly technically competent, will want to have access to all sort of information - products, financing, services - and will be 'decision-independent', meaning they will be more than capable of making their own decision as to which real estate product they will buy. The time of the stereotypical pushy, hard-selling real estate agent trying to shove a house down consumers' throats will be a thing of the past (it already is, as a matter of fact).

[ ] Diverse approach to the home transaction.

The financial impact of buying real estate will continue to be the primary consideration. Consumers will increasingly look at their home purchase as just another facet of their overall financial picture, pretty much the way they look today at stock and bond investments. Price, in fact, will supersede emotion. No more purchases dictated by the impromptu feeling of the moment. Tomorrow's buyer will be cold and calculated, and will buy only if it makes financial sense to do so. He/she will hardly fall in love with the product, even if for their own use. As such, our progenies will have no time for household chores: carpet cleaning, window cleaning, gutter cleaning will all be carried out by specialized companies or strata management companies as in the case of apartments.

[ ] The Realtor and the rise of the machine.

Consumers, both buyers and sellers, will have their own access to data from a variety of sources, but mostly from the Internet. As they will be technically skilled and computer proficient, the Realtor will no longer be seen as the primary source of real estate information. Instead the Realtor will function as an interpreter of information, both relating to products as well as to the workings of real estate, especially financing.

Realtors, moreover, will be required to be very skilled at negotiating. In essence they will function pretty much like ambassadors. It will not be only a matter of writing and presenting offers: they will be required to explain the rationale behind the offers they write. They will also be required to explain why offers have not been accepted and to provide solutions.

[ ] Entry of large-scale financial institutions.

This will probably be the largest single change in the industry. Banks will no longer be only lenders. They will become suppliers of real estate as well. With their large working capital, branch networks and back-end technology solutions they will at one time step into the industry and build, finance and sell their own real estate products with and through their own Realtors.

They will do it on a catalogue basis, so to speak. Just as you can walk into Sears today and order a vacuum cleaner on catalogue, you will be able to walk into a bank tomorrow and order a house on catalogue, perhaps a house not yet built. Pull out your own credit-card size computerized ID, and in the same branch you can view the schematics, order the interior decor, sign the offer, get the financing all set up, order the appraisal, request the lawyer, sign the warranties and I'll bet by the time you are finished about an hour later, they will give a bottle of champagne before you walk out the door, too !

A world of change is awaiting on us all. Everything will be different: vehicles, clothing, technology ... why not real estate. Doesn't all this make you feel old already ? You are not alone.

Sunday, April 23, 2006

Wait For The Real Holocaust To Come!

Leaders of the European Union should stop acting like prostitutes.

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The publication in the Danish newspaper Jyllands Posten some time ago of cartoons depicting and satirizing the Prophet Mohammed has resulted in a widespread, sometimes violent and always astonishing uproar in the Muslim world. Even worse, the foreign ministries of eleven Islamic countries have demanded action from the Danish government, and several Arab countries eventually closed their embassies in Denmark in protest after the government initially refused to intervene or to apologize.

Among the various acts of reprisal organized throughout the Islamic world, some are worth mentioning – if not for their levels of excess:

[ ] A large consumers boycott was organised in Saudi Arabia, Kuwait, and other Middle East countries.

[ ] The Foreign Ministers of seventeen Islamic countries have renewed calls for the Danish government to punish those responsible for the cartoons, and to ensure that such cartoons will not be published again.

[ ] The Organization of the Islamic Conference and the Arab League have demanded that the United Nations impose international sanctions upon Denmark.

[ ] Several Arab countries have requested that the European Union introduce blasphemy laws.

[ ] The buildings containing the Danish and Norwegian embassies in Syria were set ablaze.

[ ] In Beirut, the Danish Embassy office was set on fire, resulting in the death of one protester inside.

Muslim leaders say, that the cartoons are not just offensive - they are sacrilegious and blasphemous. This is so, because Islam forbids any visual depiction of the Prophet Mohammed – an absolute taboo in Islamic secular theology. Personally, I neither accept nor condone the virulence of those manifestations, especially since blasphemy is more than sanctioned by Arab governments. The Muslim media, in fact, routinely run cartoons depicting Jews and symbols of Judhaism with icons and images that closely – too closely – resemble those used in Nazi Germany. However, be as it may be, it is their faith and Muslims are entitled to express observance and abidance to their religion any which way they choose, in their own countries.

But only in their own countries!

Things do take a different turn, when we see Muslim demonstrators in London, Paris, Berlin and Rome holding up signs proclaiming “EXTERMINATE THOSE WHO MOCK ISLAM” and chanting “WAIT FOR THE REAL HOLOCAUST TO COME”.

Holocaust – a European word par excellence.

All Europeans are fully aware of that infamous date, November 9, 1938, known to the world as Die Kristallnacht or The Night of the Broken Glass – officially the beginning of the Holocaust. I know for a fact that they know it. I used to be a European myself.

The Holocaust was geographically widespread and systematically conducted in virtually all areas of Nazi-occupied territory, where Jews were targeted in what are now 35 separate nations of the European Union. Names like Auschwitz, Dachau, Mauthausen, Buchenwald, Sachsenhausen, Belzec, Sobibór, Treblinka, Birkenau, Chelmno, Majdanek, and Bergen-Belsen have become an integrant part of European contemporary history, and their ruins are there in Europe for every human being to see, including Muslims.

They constitute together a testament to the deepest abyss ever reached by human beings of any kind in the past one million years.

The Holocaust is so ingrained in modern European ‘civilization’, so cast into stone, that for the citizens of the country that perpetrated it, the Holocaust has become the equivalent of their second original sin – no matter when they were born !

The Egyptian Ambassador to Denmark, in a recent interview, has dismissed the Western innate right to exercise freedom of speech and expression. He has stated that exercising freedom of the press in this instance means that the cartoons will be reprinted, so that the European governments will never appease the Muslim world.

Excuse me?

So what, if European governments will never appease the Muslim world? Freedom of speech is an integral concept of modern liberal democracies, and guaranteed under international law through numerous human rights instruments, one of which being the European Convention on Human Rights. In fact, it seems to me that it should be up to Islam to appease the West, seeing as to how Islamic scholars have such a long tradition of threatening the free discussion of their religion in the West. And be it either for fear of political instability, threats to their own personal lives, social unrest or ... oil, European leaders have always acquiesced to Islamic radical demands.

Leaders of the European Union should stop prostituting themselves to each and every Arab sheik that comes into town.

European leaders have a moral duty imposed upon them to make clear, that although Muslims are more than welcome to come, live and exchange ideas with their European counterparts, they must leave their religious fanaticism, intolerance of free speech and policies of intimidation at home. European leaders have an additional duty towards their own citizens to stand tall in the defense of civil liberties, to the creation of which Europe has contributed so much throughout the course of two millennia. And they have a further moral obligation to set the record straight, by making absolutely loud and clear that also we, in the West, have our own taboos – the Holocaust being among the primary. Ultimately, Islam needs European money just as much as Europe needs Islam’s oil.

All reasonable men will agree, that there is no reason to offend people of any faith arbitrarily. We owe all faiths deference and respect. But the Danish cartoons were not arbitrarily offensive. And those who have found them offensive should be informed that freedom – the very essence of it – means learning to deal with being offended.

And as much as Muslims may find it utterly blasphemous, a cartoon depicting the Prophet Mohammed with a bomb over his head does not even remotely come close to the blasphemy of the Holocaust.

Thursday, April 20, 2006

Are We Going To See Double-Digit Interest Rates In Real Estate Again?

This question was posited to me by two clients over the week-end, and here is my expert response - for the record.

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No, we are not going to see double-digit interest rates in Real Estate any time soon. The economic and political environments today are far different from those of the early ‘80’s.

Two clients have posited this question to me, comparing the economic ravages resulting from the political situation of the 70’s and early ‘80’s with what arguably could happen today. Essentially their line of thought was that there are today so many affinities with back then, that a recurrence of the double-digit phenomenon is more than likely. Like in the ‘80’s, they contended, a new Chairman has taken control of the Federal Reserve System. The United States is involved once again in a military conflict that is dragging down the economy. America’s external debt is staggering. Employment, although not weak, is losing steam to outsourcing and there is today once again looming on the horizon the threat of stagflation caused by ever-increasing energy prices, further exacerbated by a possible military confrontation with Iran.

When Paul Volcker assumed the reins of the Fed in 1979, he indeed inherited an economy left pretty much in shambles largely by the policies, both domestic and foreign, of the Nixon Administration, the effects of which had reverberated heavily also throughout the Carter years. America had freshly ended the Vietnam nightmare, and had gone through a political oil embargo largely wanted by the Saudis and their Arab allies in retaliation for America’s open political, military and economic support for Israel, and for offering asylum to the deposed Shah of Iran, Mohammed Reza Pahlavi. The Cold War was the reality of the time, with Western Europe coming more and more under political pressure from the then USSR. And finally, a resurgent Ayatollah Ruhollah Khomeini (1900 – 1989) was set to transform Iran, a staunch US ally under the Shah, into an Islamic populist, theocratic and definitely anti-American republic - thus establishing the path of the Ayatollah’s policy towards the ‘Great Satan’, which ultimately pushed the United States to side with Saddam Hussein in the Iran-Iraqi conflict.

It was within this historic context, therefore, that Paul Volcker took command of the Fed and ended the stagflation that had plagued the United States by drastically limiting the growth of the money supply, abandoning the previous policy of targeting interest rates. As a direct and proximate consequence of a reduced pool of money, inflation peaked at 13.5% in 1981, before being successfully lowered to 3.2% by 1983, and has remained low ever since. The transition from Keynes-based policy to monetarist-based policy was a painful one, however, as it precipitated the significant recession the US economy experienced in the early 1980s, which included the highest unemployment levels since the Great Depression, as well as the highest interest rates ever. The unprecedented growth that the US economy subsequently has enjoyed over the next 25 years, however, has more than validated Volker's policies, which were continued by his successor at the Fed, Alan Greenspan.

By contrast, the world does not look nearly as ominous today.

With the advent of Reaganomics, the school of economics embracing the theory of supply-side took over. Supply-side economics is a school of macroeconomic thought, which emphasizes the importance of low taxation and of business incentives in encouraging economic growth, in the belief that businesses and individuals will use their improved terms of trade to create new businesses and expand old businesses, which in turn will increase productivity, employment, and general well-being. Specifically, supply-side economics emphasizes the importance of encouraging increases in supply and, thus, production of outputs, which result in lower prices in the marketplace and increased demand for products, thus spurring competition, increasing employment levels and generating the overall expansion of the economy.

The focus has somewhat changed after the end of Reaganomics and the advent of consumerism and globalization. The economic sensibility, sensitivity and reaction of consumers to the manipulation of interest rates has brought forth the consideration that Central banks have no handle on productivity and real economic growth, and that economy-wide recessions and booms reflect fluctuations in aggregate demand rather than in the economy's productive capacity. Thus, monetary policy is no longer viewed as a supply-side instrument but, rather, as a demand-side macroeconomics tool, at least so goes the rationale of the US Federal Reserve System and of the European Central Bank.

The impact of Reaganomics was magnified by one single event in the world’s political arena: the Soviet invasion of Afghanistan and the subsequent collapse of the Soviet Union. In December, 1979 Leonid Brehznev (1906 – 1982), the General Secretary of the Communist Party, had dispatched the 40th Army in support of the fledgling Marxist government of Hafizullah Amin. Although victorious at first, the 40th Army was dragged down in a 10-year all out war not only against the anti-Soviet Mujahideen but, factually, against the whole of Islam, which had declared a holy Jihad to combat the ‘atheist infidels’. The Mujahideen and their allies were openly and generously aided economically and militarily by the Reagan Administration (an event that the Pentagon has come to regret, in later years), and this fact was the single largest catalyst to America’s economic recovery as well as expansion, through appeasement with most of the Islamic world, which brought lower oil prices and that has lasted until today (with a few exceptions ... but, then, nobody is perfect).

It is impossible to talk about stagflation today. Stagflation is a term used to describe a period characteristic of high inflation combined with economic stagnation, high unemployment, and economic recession. It can hardly be said that there is economic stagnation and high inflation nowadays or, for that matter, widespread unemployment. In fact, both the United States and Canada are forecasting expanding economies for 2006 with an anticipated GDP of 2 percent and 2.5 percent respectively. Additionally, the political landscape today is totally different. In the era of globalization, gone are the times of major political confrontations and of more or less covert hostilities. The major economic powerhouses – North America, The Asian Tigers and the Euro Zone - have everything to lose and nothing to gain by antagonizing each others, as economic and financial interests are so intrinsically intertwined worldwide.

It is true, in my view, that in the forthcoming years the increase in energy costs, declines in both profitability and output of US major domestic industrial producers, such as the automobile and high-tech sectors, the increased reliance on imports manufactured by holders of US debt (Japan, China and India), the estimated shortfall of pension funds for an aging population, the uncertainty of value in stockmarkets and a progressive affordability crisis in real estate – all suggest that North America is entering a period of economic uncertainty which, however, greatly differs from the precepts of stagflation. Additionally, monetarist policies executed by Central Banks are now tried and tested, unlike the time when Paul Volcker took over, and there is no need for draconian measures to be enacted on the part of the Fed. In fact Ben Bernanke, the new Fed’s boss, has publicly made statements arguing in favor of a 2 percent inflation target over two years.

So, in conclusion, are we going to see double-digit interest rates any time soon? I strongly doubt it. We will see steady interest rates increases, somewhat limited in scope and spread out at intervals apart, so as to allow the economy to adjust.

Saturday, April 15, 2006

Fundamentals of Mortgage Law

Mortgages are not loans.

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A mortgage is an interest in land created by a contract, not a loan. Although almost all mortgage agreements contain a promise to repay a debt, a mortgage is not a debt by and in itself. It can be better characterized as evidence of a debt. More importantly, a mortgage is a transfer of a legal or equitable interest in land, on the condition sine qua non that the interest will be returned when the terms of the mortgage contract are performed. A mortgage agreement usually transfers the interest in the borrower’s land to the lender. However, the transfer has a condition attached: if the borrower performs the obligations of the mortgage contract, the transfer becomes void. This is the reason why the borrower is allowed to remain on title as the registered owner. In practicality, he retains possession of the land but the lender holds the right to the interest in said land.

In essence, therefore, a mortgage is a conveyance of land as a security for payment of the underlying debt or the discharge of some other obligation for which it is given. In a mortgage contract, the borrower is called ‘mortgagor’ and the lender ‘mortgagee’.

The History of Mortgage Law

Mortgage Law originated in the English feudal system as early as the 12th century. At that time the effect of a mortgage was to legally convey both the title of the interest in land and possession of the land to the lender. This conveyance was ‘absolute’, that is subject only to the lender’s promise to re-convey the property to the borrower if the specified sum was repaid by the specified date.

If, on the other hand, the borrower failed to comply with the terms, then the interest in land automatically became the lender’s and the borrower had no further claims or recourses at law. There were, back in feudal England, basically two kinds of mortgages: ‘ad vivum vadium’, Latin for ‘a live pledge’ in which the income from the land was used by the borrower to repay the debt, and ‘ad mortuum vadium’, Latin for ‘a dead pledge’ where the lender was entitled to the income from the land and the borrower had to raise funds elsewhere to repay the debt. Whereas at the beginning only ‘live pledges’ were legal and ‘dead pledges’ were considered an infringement of the laws of usury and of religious teachings, by the 14th century only dead pledges remained and were all very legal and very religious. And, apparently, they are still very religious in the 21st century.

Express Contractual Terms of a Mortgage

Following is an analysis of the clauses contained in most mortgage contracts. It should be emphasized, however, that the wording varies from contract to contract, and that the types of clauses change to conform to the particular types of securities mortgaged.

[ ] Redemption

When the mortgagor fulfills his obligations under the contract, the mortgage will be void and the mortgagee will be bound to reconvey the legal interest to the mortgagor.

[ ] Transferability

All the covenants made by the mortgagor will be binding upon him, his heirs, executors and administrators. This is the case whether the legal interest his held by the mortgagee, or by the mortgagee’s heirs, executors, administrators or assignees.

[ ] Personal Covenant

The contractual promise made by the borrower is his personal covenant. Because of this, it does not run with the land, so that the lender can sue the borrower on his personal covenant even in the eventuality that the borrower has sold the interest in land to someone else who has assumed the mortgage. In practicality, this means that until the original mortgage contract is valid, in full force and effect the original mortgagor is always liable.

[ ] Title Integrity

The mortgagor confirms and guarantees that he is the owner in fee simple and holds all rights and powers that such ownership entails, including the right to convey the land to the mortgagee.

[ ] Free and Clear

This is the very essence of the security for the debt: the title must be free and clear of all encumbrances (subject to certain statutory rights, such as taxation), so that conveyance can take place. Upon conveyance, the interest is transferred to the lender while the borrower retains possession. But on default, the borrower will deliver also possession to the lender subject to any encumbrance in priority. This can be a tax lien or, in the case of default on a second mortgage, a first mortgage.

[ ] Further Assurances

In the event of default, the mortgagor promises to do all that is necessary to allow the lender to obtain title of the property.

[ ] Prior Encumbrances

Except for statutory encumbrances, the mortgagor must make a declaration of any and all charges that have priority over the mortgage being contracted, otherwise the lender expects and has the right to be registered in first priority.

[ ] Insurance

The mortgage covenants to either keep the buildings located on said land insured at all times or, in the alternative, to provide a cash bond covering the replacement cost of said buildings.

[ ] Release of all Claims

The borrower gives up any claims he may have against the lender with respect to the property, except the borrower’s right to demand reconveyance when the underlying debt is repaid.

[ ] Acceleration on DefaultAcceleration is a proviso stipulating the on default the principal and interest of the underlying debt will both become due and payable forthwith at the option of the mortgagee.

[ ] Quiet Possession

A stipulation that, until default, the mortgagor shall have quiet possession of said lands.

[ ] Omnibus Clause

In default of any payment of money to be paid by the mortgagor under the terms of the mortgage contract, the mortgagee may pay the same and the amount so paid shall be added forthwith to the principal debt secured by the contract and carrying interest at the same rate stipulated by the contract.

[ ] Repairs

The mortgagor has a duty and an obligation to keep the lands and the buildings thereon in good conditions and in a reasonable state of repair and, furthermore, he will not abandon or commit waste anywhere on the mortgaged property. This clause is intended to safeguard the value of the lender’s security.

[ ] AdvancesThe mortgagee shall not be bound to advance any part of the money intended to be secured by the mortgage contract. For example, where part of the money has been advanced and subsequently a builder’s lien is filed against the land, the lender will require the lien to be removed before advancing further funds. Note that builder’s liens have priority over mortgages.

[ ] Sale Clause

Also known as ‘Due on Sale’ the mortgagor agrees to pay, at the option of the mortgagee, all principal and interest of the underlying debt upon sale of the property. This clause effectively prevents the mortgage from being assumed by anyone unacceptable to the lender. Obviously, the other option of the lender is not to call the loan if the mortgagor sells to a Buyer acceptable to the lender. In the absence of this clause, the mortgage is always assumable.

Monday, April 10, 2006

Let Me Help You Save $36,645 !

"To buy or not to buy. That is the question" [Shakespeare]

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This year the Bank of Canada has raised interest rates once for a total of a 20 basis points or a 0.20 percent increase. Is the Central Bank going to raise interest rates again and if so, when? This is an important question, since prospective Buyers may be putting off their real estate purchases for a variety of reasons: kids still in school, better to move in good weather, an expected salary increase. But then, does it make sense to wait? The answer is: it depends.

Let us first take a look at the historical charts. For the sake of our calculations, let us consider a 5-year term mortgage rate, which is the benchmark mortgage most consumers will take on at the time of purchase. An additional note to readers: this example is based on Canadian mortgages, which typically use compound interest. The principle, however, is equally applicable to American mortgages, with interest amortized on a straight line over the life of the loan.

The general rule of thumb is that if you can afford to make the monthly payment today, you should go ahead, lock in and buy a home. Especially these days that mortgage rates are on the rise but still low from a historic perspective - for example from the early 1990's when double-digit mortgage rates were commonplace.

Buyers who are uncertain about rates should consider locking in for three to five years. This will offer them peace of mind, so they do not have to worry about the ups and downs. This added security, however, comes at an extra cost. A study conducted by Canada Mortgage Housing Corporation (CMHC) has shown that in the 1980's and 1990's borrowers would have saved money by choosing a one-year term mortgage and renewing every year, rather than locking into a 5-year term.

If consumers do not lock in and interest rates increase, say, by 50 basis points, what will be the additional cost? Let's say you are about to buy a CAD $550,000 house with a $150,000 down-payment, and that you are considering taking up a CAD $400,000 mortgage for a 5-year term and amortized over twenty-five years. For a 5-year term at the current posted rate of 6.45 percent, the monthly mortgage payment will be $2,667.18, inclusive of interest and principal re-payment. If you wait for a year and rates increase by 50 basis points to 6.95 percent, the monthly payment will be $2,789.33. That's a difference of $122.15 per month, which amounts to a yearly increase of $1,465.80 in your cash outlays or a whopping $36,645 for the life of a mortgage over a 25-year amortization period.

Tuesday, April 04, 2006

Allah Economics

Socialist capitalism ... Ayatollah style.

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Some things are definitely meant not to be, like the Prophet Mohammed teaching capitalism to the West.

One great confusion in the otherwise already greatly confused societies of Islam is the combination and interaction of spiritual and temporal powers. Unlike the West where Church and State are separate, independent and each sovereign, Islam unites State and Religion together with less than auspicious results. Because State and Religion are one and only, for centuries Muslims have developed ways to integrate religious beliefs with the external economic realities of the nations they lived in. This has had varying degrees of compatibility with the empires and customs they encountered. For example, commerce has adapted to “al-urf”, the custom. But to adapt merchantism is one thing, to build a national financial structure with which to supervise and monitor all economic aspects of a country is quite another. The West has done it, sure ... after two-thousand years of history, trial and errors. How can Islam even remotely hope to do it in twenty years.

Since the mid 80’s Muslim bankers and religious leaders have tried to develop ways to integrate Islamic Law on usage of money with modern concepts of ethical investing. By carbon-copying western financial systems and adapting them to the religious tenets of the Qu’ran, the idea was to reinvent the wheel. But the result is a hybrid of Capitalism mixed with Socialism and sprinkled with a heavy dose of politicism so characteristic of Islamic leaders – a kind of Frankenstein with a wicked soul, so to speak. Unfortunately this notion of Islamic economics and finance bound by religious tenets is a dysfunction of economic realities and an inhibition on the development of the regions of the world where Islam is most influential, and where traditional Islamic Law remains a factor in the Middle East ongoing economic disappointments. The weakness of the region's private economic sectors and its human capital deficiency stand among the lasting consequences of the application of traditional Islamic Law to commerce and finance.

The pivotal point upon which this entire Islamic financial system is based, is that it operates on the basis of ‘zero interest’ in accordance with Qu’ran teachings. Because the Qur'an spoke against usury in the context of early Muslim society, it generally entails trying to remove or redefine interest rates from financial institutions. In doing so, Islamic economists hope to produce a more 'Islamic society'. The new Islamic economic theory postulates that in Islam, much like the West, central banks would be the sole issuer of credit and money and this for very telling reasons: Islamic central banks should be moved by public interest and their very existence should be considered a social prerogative, so that the power to create money should be vested in them exclusively. In a ‘zero interest’ society, of course, manipulation of interest rates cannot exist. Therefore the tool of Islamic monetary policy is to be found in the expansion and shrinkage of base money supply, which would be allotted by central banks to individual banks to be administered. It is further postulated as obvious, that the larger the money supply, the more productivity it generates and the more spending it spurs. This idea, for now, does not seem to have worked well.

Clearly, the first problem – and perhaps the biggest - arises in trying to model the Islamic system to the West, where fluctuations in cost of lending are paramount to monetary policies enacted pretty much everywhere. Monetary policies, as it is widely known, are technically demand-side macroeconomic policies that work by stimulating or discouraging spending on goods and services. Economy-wide recessions and booms reflect fluctuations in aggregate demand rather than in the economy's productive capacity. Above all monetary policy is not a supply-side instrument. Central banks have no handle on productivity and real economic growth. Under Islam, banks would be in competition with one another, but they would be coordinated in effect via a central bank under the patronage of an Islamic State dedicated to the people. The essence of this idea is that the State determines the policy of the central bank. Furthermore, under Islam the central bank together with the State would guard against tendencies of concentration of wealth and power, and would take suitable steps to maintain the equilibrium of wealth for the sake of the public interest, welfare and fraternal living.

To have the State telling central banks what to do brings us all the way back to the times of Leon Trotsky and the Bolshevik Revolution. In its early times, in fact, and prior to the break-up with Stalin, Leon Trotsky advocated a ‘permanent Leninist revolution’ in which the State would control all aspects of life including, of course, the economy. The State would dictate production and supply and direct monetary quotas to be used by the citizenry to purchase the available inputs. During the First and, most notably, the Second World War approximately fifty-million Christians perished fighting over the truthfulness, fairness and applicability of this idea. And whereas in fact the death of all those many people could not solve the mystery, it ultimately was the peaceful collapse of the former Union Of The Soviet Socialist Republics that revealed the ephemeral nature of the State-controlled economy.

Additionally, as Islamic countries may or may not have noticed, the United States is the single biggest importer of Islam’s number one product – oil (not explosives, like I am sure some bad mouth out there is muttering out aloud) – and the single largest payer of Petrodollars, the lifeline of economic longevity for many Islamic nations. I am willing to bet that it would be somewhat problematic, to say the least, to convince the Americans – especially the Bush Administration – that a centralized economic system based upon a Trotskyst Bolshevik-style, Marxist – Leninist State-run model is the best alternative and most viable option to capitalism available anywhere in the Universe. Not even Vladimir Putin, the current president of the Russian Federation and former KGB officer and FSB boss, talks about State-centralized economy anymore. This new idea sounds too much like a very old one or, to use one of America's favorite expressions, 'different day, same old s..t'.

The second problem created by the ‘zero interest’ society is that the fundamental characteristic of charging interest, i.e. charging a premium, on the principal amount of a loan for the time value of the loaned money, is not truly eliminated in Islamic banking. Rather, the interest is merely hidden and re-labeled. A fact this, all and by itself, which goes against Qu’ran teachings in the matter of not deceiving your fellow Muslims.

Usually, time value of money is compensated to the lender by the lender charging the borrower interest on the principal amount of the loan. In the case of Islamic banking, the lost time value is compensated by charging a mark-up on the product that the client might be seeking to purchase by way of a loan. The ownership of the product, whether a real capital asset or personal property, remains in the name of the bank until the principal loan including the mark-up has been paid. In the case of a business loan, instead of charging interest over the time that the principal amount is loaned out, an Islamic bank will demand a certain percentage of the borrower's business profits for an indefinite period of time. Furthermore, under a conventional interest-based loan it is possible to ‘call’ the loan if the interest rate drops and the borrower discovers that he can find cheaper financing. However, there is no way to call a loan issued by an Islamic bank. Thus, while the borrower from an Islamic bank is protected against interest rate increases, the borrower cannot benefit from interest rate drops.

All this, coupled by less than efficient social structures and political systems in many Islamic states, contributes to the existence of quasi-feudal living standards for the vast majority of Muslim individuals and businessmen alike. Ironically, in the few areas where this new Islamic economic reality has been and is now being tried and tested, rather than finding the much coveted equilibrium the ‘Islamic initiative’, as it has come to be known, seems to have exacerbated the polarization of wealth.

Certainly it does not appear that Allah can be either proud of or happy, at least for the time being, for the financial under-achievements of Her devout followers.